Don’t be suckered into giving your customers credit – unless you intend to be a creditor, which requires complying with the large number of consumer credit laws that apply to credit transactions with consumers. Otherwise, you could find yourself on the wrong side of an expensive life lesson in the form of a regulatory action or consumer lawsuit for failing to comply with those laws.
Is it really possible to accidentally grant credit to a consumer?
Yes, it is possible to become an accidental creditor. This can happen if you regularly allow your customers to pay in installments or if you impose a late fee that is couched in terms of “interest.” (See this post for more on how to charge late fees legally.) This stems from the definition of “creditor” under federal law, which defines a creditor as someone who:
. . . regularly extends consumer credit that is subject to a finance charge or is payable by written agreement in more than four installments (not including a down payment), and to whom the obligation is initially payable, either on the face of the note or contract, or by agreement when there is no note or contract.
Similarly, the Truth in Lending Act’s definition of “credit” includes “the right granted by a creditor to a debtor to defer payment of debt or to incur debt and defer its payment.”
What Does it Mean to “Regularly” Extend Credit?
A careful reader will note that the definition of “credit” includes someone who “regularly” extends credit. What does this mean? Federal law defines it as extending credit more than 25 times in a calendar year.
If it takes 25 transactions in a year to be considered a creditor, how can someone accidentally become one? Let’s do the math: if a merchant or service provider allows just two customers each month to pay her back in installments, she’s just one transaction away from becoming a creditor.
Also, it is possible to be a creditor under state law even if you do not fit the definition under federal law. In this case, you may not need to comply with the federal law (although you might, if the state law incorporates the federal law), but you’ll need to pay attention to the laws in your state, which may include the need to obtain a lending license.
The safest course of action is, of course, to avoid the issue by not extending credit to any of your customers. But, the reality is, sometimes merchants and service providers want to be helpful to their customers and allow them to pay over time. If you want to allow any of your customers to defer payment or need advice on how to charge a late fee without worry, check with a consumer finance attorney who can advise you as to the laws applicable to you. While many attorneys have generalized knowledge, those of us who are well-versed in consumer finance law are a relatively rare breed, so be sure to ask the attorney about her experience with consumer finance laws. This will help you avoid being punished for your good deed and help prevent the need for her services later – in court. It is far less costly to seek the advice of an experienced attorney up front than to pay her to defend you in court.
I Do Not Allow Customers to Pay Over Time – I’m Safe, Right?
Not necessarily. Another way to become an accidental creditor is to charge interest (or a late fee that looks like interest) when customers are late in paying what they owe. See this post for more on charging late fees without opting into consumer finance laws.
Bottom line: tread softly whenever you’re considering allowing customers to pay for your goods or services over time. Be mindful of the possibility of becoming a creditor if you do so. If you do become a creditor, there are numerous things you’ll need to be aware of, from licensing to compliance with an entire alphabet soup of consumer lending laws (TILA, ECOA, FCRA, GLB, etc.). All of which is fine, if you’re ready for it. But, be sure to talk with an experienced consumer finance attorney if you decide to do this because there are plenty of mine fields for the unwary.
Covering my bases: There is no legal advice contained in this post. Legal advice entails applying the law to specific facts. I don’t know what your facts are and any resemblance to them here is purely coincidental. Instead, this post is meant to provide general information, which may or may not be complete and accurate. If you need legal guidance, please feel free to contact me using the contact information on my firm’s web site – www.westbendlaw.com.